The 10% Penalty on Withdrawals from Retirement Accounts

Money you hold in a retirement account may be subject to a 10% penalty if you touch the money before you turn age 59 ½. Sometimes, though, you can withdraw the money and avoid the penalty.

Because nothing with taxes is ever easy, the rules are sometimes the same and sometimes different, depending on if the money is in an IRA or in an employer plan such as a 401(k).

The distinction between IRA and 401(k) rules is important because it can trip people up. More than once I have helped a client who took money from their 401(k) plan to make a down-payment on a home and assumed it would be penalty free. The problem is, the exemption for the penalty for a home purchase applies only to IRA withdrawals, not 401(k) withdrawals. 

It’s also important to remember that a withdrawal will still be subject to income taxes*. What we are talking about here is the 10% penalty.

(Unless the withdrawal is from a Roth account or a traditional account with post-tax basis, in which case some or all of the withdrawal may be tax-free. Remember, nothing is ever easy.)

Penalty Exceptions

Consult Form 5329. There is a list of 18 codes that are exemptions from the 10% penalty.

Code 01: Applies to qualified plans only, not to IRAs. If the recipient separated from service after age 55 (or age 50 for certain public safety employees) then the penalty does not apply.

Code 02: A series of substantially equal payments. This basically means that you are withdrawing from the retirement account based on published actuarial tables. Even if you are under age 59 ½, this type of withdrawal is not subject to the 10% penalty.

Code 03: A withdrawal due to disability. You must be totally and permanently disabled. Withdrawals of someone who is totally and permanently disabled are not subject to the 10% penalty.

Code 04: Death distributions. This means you have inherited a retirement account from a deceased person. Your withdrawal as a beneficiary is not subject to the penalty. 

Code 05: 401(k) only – withdrawals to pay for medical expenses exceeding 7.5% of your AGI are not subject to the penalty. Only the portion of expenses above 7.5% of AGI qualifies for the penalty exemption.

Code 06: Certain divorce distributions under a qualified domestic relations order (QDRO). Applies to 401(k) plans only.

Code 07: Applies to IRA withdrawals only – withdrawals of unemployed people to pay insurance premiums are not subject to the 10% penalty.

Code 08: Applies to IRA withdrawals only – withdrawals to pay higher education expenses are not subject to the 10% penalty.

Code 09: Applies to IRA withdrawals only – withdrawals of first-time homebuyers (up to $10,000) are not subject to the 10% penalty.

Code 10: Applies to qualified plans only – withdrawals because of an IRS levy are not subject to the 10% penalty. 

Code 11: Withdrawals made by reservists on active duty for at least 180 days are not subject to the 10% penalty. Applies to qualified plans and IRAs.

Code 12: Distributions incorrectly coded as early distributions on Form 1099-R (i.e. someone over age 59 ½ receives a 1099-R showing that the distribution is subject to the penalty, when in fact they are not subject to the penalty).

Code 13: Distributions from a section 457 plan, which aren’t from a rollover from a qualified retirement plan. A 457 plan is a type of deferred compensation plan that some governmental and non-profit employers offer. These plans are similar to qualified plans but are NOT qualified plans. They have their own rules for distribution of the money. There is no early withdrawal penalty, but again, 457 plans have their own rules on “when” you can access the money, and the withdrawal may be taxable (but not subject to a penalty).

Code 14: Qualified plan withdrawals to people who separated from service by March 1, 1986, and a distribution schedule is in place and being used. These withdrawals are not subject to a penalty. (NOTE: pretty much anyone who is in this boat would likely be over age 59 ½ by now anyway, but the exception still exists.)

Code 15: Distributions of dividends under an ESOP – employee stock option plan. 

Code 16: Per the instructions to Form 5329 – “Distributions from annuity contracts to the extent that the distributions are allocable to the investment in the contract before August 14, 1982.” These withdrawals are not subject to the 10% penalty. 

Code 17: Per the instructions to Form 5329 – “Distributions that are phased retirement annuity payments made to federal employees.”

Code 18: Qualified plan withdrawals under 414(w). What does this mean? Certain qualified plans have “automatic enrollment” provisions. Withdrawals of deferrals made under an automatic enrollment provision not be subject to the 10% penalty.

Code 19: Qualified birth or adoption distributions. Taxpayers can withdraw, from an IRA or a qualified plan, up to $5,000 penalty free up to 1-year after the birth or adoption of a child. 

Code 20: Distributions due to terminal illness. Applies to IRAs and qualified plans. Per the IRS  “Distributions that are made after the date on which your physician has certified that you have an illness or physical condition that can reasonably be expected to result in death in 84 months or less after the date of the certification.” These distributions are not subject to the 10% penalty.

Code 21: Certain corrective distributions in a qualified plan are not subject to the 10% penalty.

Code 99: The instructions for Form 5329 say to enter this code if more than one exception applies.

Other Notes and Tidbits

As said early on, the distribution will generally still be subject to income tax. These exceptions are just for the 10% penalty.

Also, it’s possible that you might be able to access the money for a valid reason but still be subject to the penalty. Take, for example, a hardship distribution from a 401(k) plan. There’s a whole separate set of rules relating to hardship distributions, and you might be able to meet those rules and access the money while still working for the employer. However, those withdrawals are not necessarily exempt from the 10% penalty. 


Use Form 5329, put the proper code(s) on the form, and it will do the math on calculating if any penalty is owed. We will look at an example in an upcoming post.